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Moscow Times
April 7, 2005
Putin Is No Frederick the Great
By Alex Fak
Staff Writer

When Frederick II decreed an independent judiciary in Prussia, he was promptly sued by a farmer over a land disagreement. Frederick lost the case and had to pay up.

Yevgeny Yasin, an economist and former finance minister, related the story at a recent American Chamber of Commerce conference in Moscow and said: "The previous German ambassador here, Ernst-J?rg von Studnitz, told me, 'You Russians think we call Frederick II 'the Great' because he built up the Prussian army. ... Actually, we consider him 'the Great' because he established the precedent of judicial independence."

By this standard, President Vladimir Putin is as far from earning the moniker as ever. The forced sell-off of Yukos subsidiary Yuganskneftegaz has widely been seen as pivotal proof that "the state is prepared to overrule the judicial process [and] won't even play by its own rules," said Al Breach, an economist with Brunswick UBS who once was among the more optimistic Russia commentators.

Indeed, the Kremlin has shown an intensified penchant for meddling both at home and abroad with its consolidation of presidential power after the Beslan school attack, its ultimately disastrous interference in Ukraine's presidential election, its backing of the state's renewed domination of "strategic" industries and its attempts to call both fiscal and monetary policies. Commentators widely failed to predict such a turnaround a year ago.

"A Russia that falls back onto a statist economic model will fall further behind a rapidly developing world -- and its own immediate neighbors," U.S. Ambassador Alexander Vershbow warned in a speech last month.

Some foreign business leaders, however, remain optimistic. Putin's steps to increase his powers may be positive for business, said Andrew Somers, president of the American Chamber of Commerce in Russia.

"Almost all the American companies here continue to do extremely well," said Andrew Somers, president of the American Chamber of Commerce in Russia. "I'm having meetings with CEOs of American companies that are definitely coming onto the market next year."

The crystallization of the state's role in the economy has been made even starker by the government's failure to deliver on most of the reforms it has promised. In March 2004, Russia watchers were hoping that Putin would use his political muscle to crack down on corruption, restructure the bureaucracy and push through austere reforms opposed by vested monopolist interests. After all, Putin had fired the Cabinet three weeks before his March 14 re-election in what he had called an attempt to get on with the reforms faster.

But it was not to be.

"A year later, almost nothing has happened," said Chris Weafer, chief strategist at Alfa Bank.

Even the most optimistic analysts struggle to list reforms that were successfully implemented over the past year. Only two readily pop into mind -- the enactment of mortgage legislation and the cancellation of social benefits in favor of cash payments -- and the social reform created widespread unrest because the government failed to sell the plan to those who would be affected.

Meanwhile, the initially trumpeted administrative reform has only managed to add an extra layer of bureaucracy, while the planned restructuring of Unified Energy Systems and Gazprom has yet to go beyond hopeful talk.

The most-awaited reforms -- a stimulation of inward investment and a crackdown on corruption -- have not moved anywhere. Corruption is believed to cost business $50 billion per year in delays, administrative expenses and outright bribes -- some 10 percent of the country's annual gross domestic product, Weafer said. Moreover, while taxpayers are winning most cases against tax authorities, nebulous laws mean that many courts continue to sell their rulings to the highest bidder.

"Contracts are very, very hard to enforce in Russia," said a British lawyer who advises Western firms slighted by their Russian partners. "If the Russian side wants to f--- you up, they absolutely can."

The Kremlin has even ham-handedly tried to beat the laws of economics. In April, it set tough targets for the nominally independent Central Bank on stemming ruble appreciation and inflation -- contradictory goals, considering the bank's limited tools. In the end, tight monetary policy attracted strong capital inflows and forced the Central Bank to abandon its weaker-ruble policy even as it lost control over inflation.

Once-pugnacious Kremlin reformers have gone on the defensive.

"Liberals who have drafted the reform agenda say that rather than push for more reforms, they are struggling to preserve the ones they have managed to implement," Breach said.

Continued backtracking has also undermined a lot of trust in the president. Although a well-placed phrase from Putin could once rally markets, shares barely reacted on the benchmark RTS index after the president offered last month to put a moratorium of three years on reviews of privatizations and to curtail the discretionary powers of the tax authorities. Last year, the authorities collected an estimated 470 billion rubles ($16.8 billion) in back taxes, compared with less than 150 million rubles in 2003, according to the World Bank.

"There is not much benefit of the doubt left," said Alexei Moisseyev, an economist with Renaissance Capital. "They have promised all the best things before, reneged, and now they are starting to promise those very same things again."

Opinion is divided on whether the lethargy over reforms demonstrates an ideological shift by Putin toward statism or is just the result of continued infighting within Prime Minister Mikhail Fradkov's Cabinet.

"The main reason for the deceleration of structural reforms ... has been the disorganization of the new [Cabinet] team," said Christopher Granville, chief strategist at United Financial Group.

Weafer said he believed the reforms simply ran into the wall of bureaucracy. "People in the government say Putin has become so frustrated with either the incompetency, the idiocy or the laziness of government officials that he basically believed the broad reform program ... would be a wasted effort," he said.

Weafer said he saw a sea change toward "giantism" in the state's economic strategy. Dropping its former goal of buoying small and medium-sized businesses and the underinvested manufacturing sector, "now we see the Kremlin selecting a smaller number of strategic industries: where either there is existing growth like oil, metals, minerals; where Russia has competitive advantage like aviation or the defense industry; or key infrastructure industries like banking and telecoms," he said.

Moreover, the state has muscled its way into becoming a chief player in all the major industries except mining, making it both regulator and major competitor. "The combination of national industrial policy plus national champion industries has never worked in any country, ever," Weafer said.

With the Kremlin facing a tough campaign ahead of the 2008 presidential election, in which Putin is constitutionally barred from standing, many analysts believe the window of opportunity may have closed. "Reforms almost necessarily hurt someone, and you don't want to hurt people when the politics, rather than governance, is on your mind," Breach said.

The fundamental reversal of government policy over the past year has had mixed effects on the economy. Real incomes and wages rose faster than GDP, and the number of people living below the subsistence level has decreased. But fixed capital investment slowed, according to the World Bank. Capital outflows have intensified. Lack of structural reforms and increased political uncertainty have held back investment in non-oil sectors, while underinvestment has constrained capacity and helped to almost double producer inflation last year to a staggering 28.8 percent. Standard & Poor's declared in February that Russia "is becoming a classic victim of 'Dutch Disease.'"

On equity markets, the RTS index shed 9 percent in the year to April 1, even as the MSCI emerging markets index soared 13 percent.

Weafer cited figures that show that about 80 percent of corruption costs arise at the regional or municipal level.

But it is unclear how the changes would tackle corruption rather than just move it to the federal level, Weafer said.

The effects of power consolidation and lack of reforms will be felt more keenly in the medium term than right away -- especially if the Kremlin does not manage a smooth transfer of power in 2008. "One should invest now for the next year or so, but be mindful of 2008 coming up because there could be a very nasty political fight brewing," Breach said.